The Good, The Bad And The Ugly Of Brexit

Lankan Economy To Be Adversely Affected

by Amavasya Sirisena

With the conclusion of the referendum in the United Kingdom regarding its European Union (EU) membership, academics and economists predict that Brexit is likely to unfavourably affect most economies in general and the Sri Lankan economy in particular.

Although world economists have different opinions on the impact of Brexit on Britain, the majority of Sri Lankan economists along with the corporate leaders believe that Sri Lankan economy could be adversely affected. This is because that 10 per cent of Sri Lanka’s exports go to the UK amounting to over US$ one billion (approx. LKR 139 billion) in comparison to 28.8 per cent of exports that go to the entire EU bringing in the country US$ three billion (approx. LKR 411 billion) foreign exchange.

Economist Deshal de Mel commenting on the impacts of Brexit on Sri Lanka stated, “The most important short term implication comes because Sri Lanka is looking to tap global bond markets to roll over its external debt repayment obligations in the coming months. A market risk event like Brexit causes global investors to shift to safe assets such as US treasuries, gold, and currencies such as Japanese Yen and the Swiss Franc, whilst moving out of perceived ‘riskier’ assets such as emerging/frontier market bonds and stocks. This causes investors to demand higher yields on assets such as Sri Lankan government debt, making it more expensive for the government of Sri Lanka to borrow from the global market. However, the ‘risk off’ mode in markets is unlikely to persist for a prolonged period, and if there is an indication that the US Fed might delay its rate hike plans in response to the market situation, the bond market may again be positive for Sri Lanka. It would be crucial for the government of Sri Lanka to time its entry to the global bond market perfectly.”

He further said, “The other important implication of Brexit is the weakening of the Sterling Pound. With the sharp depreciation of the Great British Pound (GBP) against global currencies, imports will become more expensive for UK citizens. and this could affect demand for Sri Lankan exports to the UK. A weaker Pound will also affect outward British tourists, an important source of tourism for Sri Lanka.”

“In the medium term, Brexit will create uncertainty among investors and the labour force, and this will undermine economic dynamism and activity in the UK, which would again be a negative for Sri Lankan exports to that market. Finally, if Sri Lanka does secure GSP +, there will be an opportunity loss given that this benefit would no longer apply to the UK market. A separate bilateral trade deal with the UK would take time to negotiate and implement, and it would not be non-reciprocal, unlike GSP +,” he added.

He further highlighted, “In addition to the implications for the currency and the result of uncertainty on investment and business activity, the main implication would be question marks over continued liberal trading access to the EU market. It remains to be seen what kind of trade agreement the UK strikes with the EU – it is likely to be a weak one if the EU is intent on deterring other countries from following Britain’s example. Whilst this would not cripple Britain’s export capability, it would definitely weaken its trading position. The other question is, of course, whether the UK itself would remain in its current form, or whether Scotland would choose to leave the UK and join the EU.

“Most of the economic implications have already been touched upon. Beyond economics, the political implications of Brexit are significant. Globalization has already suffered due to the global economic crisis since 2009, and Brexit will be a further blow. This is likely to set back efforts of other countries to deepen market integration as the political ramifications of such moves are now a lot more tangible. If other European countries decide to follow Britain’s lead and call for fresh referendums, particularly in the context of the refugee crisis, the outcome for the European integration project could be bleak. Brexit is a manifestation of the political limits to globalization, particularly with regard to labour mobility, and the result is likely to be a further slowdown in global trade and economic integration,” stated de Mel.

Speaking on Brexit, Immediate Past President of National Chamber of Commerce of Sri Lanka Sunil Wijesinha also stated that it could have both short term and long term impacts on Sri Lanka.

He added, “There will be many kinds of impacts. If the British economy declines further, it will impact on demand for imported goods and services and consequently exporting countries such as Sri Lanka will suffer through reduced exports. The decline in the UK Pound may not impact on Sri Lankan exports immediately because Christmas season orders may have already been finalized and also much of the exports, I believe, is in US Dollars. However, there will be pressure for lower prices for future orders. When Britain finally leaves the EU, then EU GSP will not be available for exports to Britain and in the event our application for EU GSP+ is successful, we will not benefit from exports to Britain unless a new trade agreement can quickly replace it. The lower Pound will make it more attractive for Sri Lankans to holiday in Britain while for British tourists it will be more expensive to travel. Consequently British tourists to Sri Lanka may reduce.

“The volatility in financial markets and the dampened risk appetite of investors will affect Sri Lanka’s international borrowings and capital flows to the country. In the longer term, a slowdown in the British economy may affect our exports because around 10 per cent of our exports currently go to that market,” he further added highlighting the possible impacts that the Sri Lankan economy will encounter in the near future.

H also said, “The impact could be quite adverse. Already several global banks have sharply downgraded the growth forecast for this year and next year. Britain’s position as the key financial hub in Europe may also be threatened, as some banks relocate part of their operations to other EU capitals like Frankfurt. British exports to the EU would also have to face tariffs, unlike now where it is zero tariffs under the European common market. Politically too, there may be new movements in Scotland and Ireland to think on new lines.”

Commenting further Wijesinha stated that the impact is not yet clear.“If the financial market volatility continues, then this would hurt economies across Europe and Asia. Slowdown in the British economy will affect countries across Asia that consider Britain a key export market. Countries that already enjoy EU GSP+ and those least developed countries that have entry under the EU EBA agreement such as Bangladesh may face higher tariff in their exports to Britain. In long term, if Brexit affects the growth and dynamism of Europe as a whole, this will be a dampener on global growth. The global economy is already going through moderation right now, and anything to aggravate the situation will affect growth. However, the effects may not be substantial unless the exit of Britain becomes really messy, and also if other countries vote to leave the EU in the coming years. It all depends on how the exit is handled and what the new economic agreements will be.”

The Ceylon Chamber of Commerce Chief Economist, Anushka Wijesinha, commenting on the issue has recently stated that emerging markets like Sri Lanka could be affected since investors tend to go to safer assets like dollar and gold.

He also highlights the need of a bilateral deal with Britain as regaining GSP plus will not help in our market access to Britain. “We will certainly not be the first in line for the bilateral trade deals – estimates suggest Britain will have to do over 100 bilateral trade deals, which would take years,” he said.

“In the longer-term, if Brexit triggers other exits by other member countries (and there is no reason to believe this is immediately likely), this will affect the Euro and increase trade costs in Europe, which of course affects market access and competitiveness of Sri Lankan exports to Europe. Sri Lanka could also be impacted by a wider slowdown in the global economy. Economists have estimated that Brexit could cause global growth to dip below three percent which is tricky territory.”

EU and Britain

The UK used to be the sick man of Europe. Economists from the Leave side pointed out that the absolute growth rates were lower after 1973 than before and that the main reason for Britain’s improved performance was Margaret Thatcher’s reforms, not EU membership.

Splitting correlation from causation is difficult. All countries’ growth slowed after the postwar surge petered out. But, given the dramatic improvement in Britain’s position, it is nearly impossible to argue that the EU stood in the way of Britain pulling up its socks. In the most detailed assessment to date, Professor Nick Crafts of Warwick University, Britain’s leading economic historian estimates that the EU directly raised UK prosperity by about 10 per cent, largely due to increased competition and better access to the single European market.

What trade deals will replace European Union membership?

What will a new ministry of trade have to do after the country breaks off with the EU to replace current trading relationships? Sign a deal with the remaining 27 members of the EU, come to an arrangement with about 50 additional countries with which the EU has preferential deals, or all the remaining 161 members of the World Trade Organisation?

A bilateral deal with the bloc is likely to take years to negotiate, say experienced trade negotiators. Barack Obama, the US President, has also cautioned that Britain would be “at the back of the queue” for a US-UK trade deal.

The Leave campaign said the UK does not need trade agreements to trade. It said that Germany and other countries running trade surpluses with the UK would eagerly seek a preferential deal and the UK could be much more nimble in negotiating deals with other countries.

Leave side was right that trade deals are not necessary for trade. But such agreements do set the rules for commerce and protect Britain and UK companies from disputes and arbitrary actions from other countries. Leaving the EU will require a mammoth negotiation process, since Britain cannot even guarantee to be able to trade securely under WTO rules, since it does not have its own schedule of tariffs, commitments on services and agricultural subsidies. Without this, Britain will be left vulnerable to legal action under WTO dispute settlement rules.

Could Britain cut migration!

Britain’s net migration stood at 333,000 in 2015, the second-highest figure on record and more than three times David Cameron’s 2010 pledge to bring the figure down to the tens of thousands. Net immigration from EU countries, particularly central and eastern European member States, rose rapidly after their accession to the EU in 2004 and more recently, when citizens of Bulgaria and Romania acquired the right to work and settle in the UK. Only by leaving the EU can the government reduce the numbers of EU migrants.

EU migrants tend to be young and are likely to be employed. They contribute more to the UK public finances than they take out and much more than UK-born citizens. And their numbers already appeared to be plateauing, now that the initial surge from Romania and Bulgaria has abated.

Even if EU net migration was cut to zero, Britain would have far more migrants from non-EU countries than the Prime Minister’s tens of thousands pledge. As long as Britain’s economy does well, it will attract immigrants.

Impact of Brexit on FDI in UK

There are at least three reasons why Foreign Direct Investment (FDI) might fall if the UK left the EU: First, being fully in the Single Market makes the UK an attractive export platform for multinationals as they do not bear potentially large costs from tariff and non-tariff barriers when exporting to the rest of the EU. Second, multinationals have complex supply chains and many co-ordination costs between their headquarters and local branches. These would become more difficult to manage if the UK left the EU. Third, uncertainty over the shape of the future trade arrangements between the UK and the EU would also tend to dampen FDI.

Overall, Brexit is likely to have a negative impact on inward FDI. New empirical analysis by Center for Economic Performance implies that leaving the EU will reduce FDI inflows to the UK by around 22 per cent. Such losses of investment will damage UK productivity and could lower real incomes by 3.4 per cent. This is larger than our estimates of the static income losses from trade, which are 2.6 per cent even under our ‘pessimistic scenario’ (Dhingra et al, 2016). Case studies of cars and finance also show that Brexit would lower EU-related output of goods and services, and erode the UK’s ability to negotiate concessions from regulations on EU related transactions.

Economic shockwaves

The Brexit victory sent economic shockwaves through global markets and UK stocks on June 24 had their worst drop since the financial crisis. The pound on Friday fell to its lowest level since 1985 and emergency steps are now being taken to calm the economic turmoil. There is uncertainty over what will happen when Britain leaves the EU because it has to make new trade agreements with the rest of the world. Bank of England Governor Mark Carney said: “Some market and economic volatility can be expected as this process unfolds. But we are well prepared for this.” Supporters of Brexit argue that EU countries have every incentive keep trading with the UK, which is a large importer of goods and services. But Europhiles worry that foreign companies will be less likely to invest here and could relocate their headquarters if Britain loses access to the EU’s single market. Ahead of the referendum, investor Neil Woodford, founder of Woodford Investment Management, described pro-European claims that the economy would be damaged as “bogus”.

(Sources: – www.ft.com & thecurionomist.wordpress.com)

What is Brexit?

Brexit is an abbreviation of “British exit”, which refers to the June 23, 2016 referendum by British voters to exit the European Union. The referendum roiled global markets, including currencies, causing the British pound to fall to its lowest level in decades.